CBDT's Clarification as Regards Application of MFN Clause for Lower Rate of Source Taxation

The Central Board of Direct Taxes issued a clarificatory circular on 03.02.2022 pursuant to receipt of representations for clarity as regards application of MFN clauses available in the protocol to some of the DTAAs with OECD members. It sought to clarify as to whether the lower rate of source based taxation in respect of dividends, royalties etc. as prescribed in India’s DTAAs with countries such as Slovenia, Colombia and Lithuania will apply to prior DTAAs with other OECD members considering the fact that the states like Slovenia, Colombia and Lithuania were not the members of OECD at the time of entering into DTAAs with India but became OECD members subsequently.

CBDT considered the unilateral position taken by Netherlands (Decree No. IFZ 2012/ 54M dated 28.02.2012), Switzerland (publication by the Federal Department of Finance, the Swiss Confederation on 13.08.2021) and French official bulletin of Public Finances-Taxes published by DGFIP on 04.11.2016 declaring that the rate of tax on dividends under the respective DTAAs with India stood modified to a lower rate under the MFN clause after India entered into a DTAA with Slovenia, which became an OECD member on 21.07.2010.

Clarifications Issued

Clarifications issued by the CBDT are primarily to the following effect

1. Unilateral decree/ bulletin published by another state do not represent shared understanding of treaty partners.
2. For applying MFN clause for lower source taxation rate prescribed in DTAA with a third state, said third state must have been an OECD member on the date of conclusion of DTAA with India.
3. DTAAs clearly provided that reduced rate took effect from the date of entry into force of Indian DTAA with third state; ergo declaration in bulletin/ publication/ decree of Netherlands, France and Swiss Confederation to apply reduced rate from date of third state becoming an OECD member on some future date when such third state was not an OECD member on date of signing of DTAA with India, was not proper and was not in accordance with MFN clause in the Protocol.
4. For applying MFN clause for lower source taxation rate prescribed in DTAA with a third state, amendment to DTAA must be notified in official Gazette in terms of provisions of s.90(1) of the Income Tax Act, 1961.

Above essentially means that the MFN clause in DTAAs with treaty partners will not get triggered if India subsequently entered into DTAAs with other (Non-OECD) treaty partners like Colombia, Slovenia, etc prescribing a lower rate of source taxation, even if they later became OECD members.

Delhi High Court Decision on the Aspect

The aspects have already been considered elaborately and dealt with by Delhi High Court in the case of Concentrix Services Netherlands B.V. v. ITO (W.P.(C) No. 9051/ 2020) where the taxpayer had applied for a lower withholding tax certificate in terms of India-Netherland DTAA read along with the Protocol thereto. The facts pertaining to lower rates of taxation in treaties between India and Slovenia, Lithuania, and Columbia and the aspect of these states having become OECD members at a date subsequent to the date of conclusion of DTAAs with them was considered.

The High Court considered submissions of the assessee and the department and broadly held that

1. MFN clause was an integral part of a treaty and no fresh separate notification was required for applying the provisions of MFN clause.
2. The conditions required to be satisfied for applying MFN clause were that the third state with which India enters into DTAA subsequently, should be an OECD member and treaty with such a third state must prescribe a lower rate of withholding tax as compared to the rate mentioned in the Treaty containing MFN clause.
3. The word ‘is’ as contained in the phrase ‘which is a member of the OECD’ did not require that a third state must be an OECD member on date of conclusion of DTAA with it but rather the requirement was for such third state’s being an OECD member when a request was made by taxpayer for lower rate withholding tax certificate.

OUR VIEWS

The circular issued by the department, though making some interesting points, runs contrary to Delhi High Court Decision. Currently, there does not appear to be any appeal filed by the department before the Supreme Court challenging the decision in the case of Concentrix, and in that circumstance, it is uncertain when will the Supreme Court be able to consider the issue.

Furthermore, in terms of the decision in the case of CIT v. Hero Cycles Pvt. Ltd., it is a settled law that any Circular issued by CBDT binds the assessing officer but not the assessee or Income Tax Appellate Tribunal or any High Court.

In that scenario and absent any conflicting decision from any other High Court, there is no reason same interpretation should not be applied for any cases on the aspect across India especially when Interpretation by one of the High Courts (of Delhi State) is on a Central Statue (Income Tax Act, 1961) and Tax Treaty and not on any state legislation.

Pune Tribunal, in the case of GRI Renewable Industries S.L., has recently held that Protocol to a treaty (India-Spain) which was an integral part of the treaty, stood automatically notified with the treaty and there was no need for separate notification for applying MFN clause. Tribunal, in this case, did not consider whether other conditions in the recent CBDT circular were quintessential for applying the MFN clause as there was no dispute about the fulfillment of other conditions. This decision (as regards separate notification not being required) of the Pune Tribunal will bind all other ITATs across India.

To have certainty, a non-resident recipient of interest, dividend or an Indian payer could consider option of advance ruling / challenging the circular before the High Court or making an application for lower withholding tax rate before assessing officer and taking the matter to concerned High Court in a writ proceeding post rejection.